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How much can you say when you raise private money?

Matt MarshallDecember 16, 2004 2:38 PM

Over the past year, it seems, more and more start-ups, venture capital firms and other types of private investment funds have been announcing publicly that they’re looking to raise money. Maybe we’re missing something here, but we thought that security laws forbid you from publicly soliciting funds — a way of protecting unsophisticated investors from being duped.

The latest example comes from today’s VentureWire, which requires a subscription. We read that San Jose’s Applied Microstructures Inc., which develops and designs nanotechnology deposition equipment, says it plans to raise $8 million in a second venture capital round to develop new products.

Jeffrey D. Chinn, founder, president and chief executive of Applied Microstructures, tells VentureWire that the company has a dozen customers, including big names like Hewlett-Packard and Agilent. He said the company will:

… start approaching venture capital firms in the first quarter of 2005 and will be looking for a new investor to lead the round with about $5 million to $6 million. The company plans to close the round sometime in the spring….Chinn expects 2004 revenue of $1.6 million, and 2005 revenue of $5 million. He anticipates that the company will reach profitability in late 2006….The company claims that its systems can reduce coating costs.

True, VentureWire’s readers are paying something to read the articles, and so are probably more informed and sophisticated than the average joe investor. Still, any individual is allowed to subscribe to it, not just sophisticated investors. We sent this and about a dozen other examples over to Alan Mendelson, an attorney at Latham & Watkins to see what he thought.

Here’s his response:

“I would bet that most of these guys are doing these interviews without calling their counsel,” he said. “If youï¿½re using the press to find investors and make it an actual solicitation, that arguably puts you in violation of the securities act.” He said the company could argue it is merely announcing general stuff, and not soliciting people directly, and that readers would know they werenï¿½t being solicited per se. The trouble, though, is that under the Securities Act, an individual or venture capital firm investing in such a start-up needs to assert that they “didn’t learn about the company from a mechanism designed to be a broad based solicitation,” Mendelson explains. “Iï¿½m a little bit surprised that these guys would do it,” he said of the long list of recent examples, which include companies like Mountain View’s Avidia Research Institute, Zelig Networks, PubSub Concepts, Panacya and Game Trust. “Maybe theyï¿½re unsophisticated,” Mendelson said.

Venture capital funds have been making similar announcements about their fund-raising, which Mendelson says he’s more forgiving of because most investors in venture and other private equity firms are highly sophisticated. Still, their announcements contrast with the extreme secrecy which with firms like Kleiner Perkins or Elevation Partners have pursued funding. Both stated to us that they couldn’t say anything about their fund-raising because of security laws. Indeed, the elaborate dance taken by some to attain press is a tad amusing as the following example shows…
It concerns Breeze Venture Partners (we couldn’t find a Web site), in an article by reporter Sree Vidya Bhaktavatsalam — also in today’s VentureWire. Unfortunately, we don’t have a link for it. She writes about how the newly formed Breeze Venture Partners is looking to raise a first so-called “fund of funds” earmarked mainly for Russian funds, which she notes is “perhaps the first ever vehicle of its kind.”

The article gives details of how much money the Russia Strategy Fund is aiming for ($50 million) and several other aspects of its plan. It then gives the rosy spin provided by Russian experts, i.e., “that the legal framework, the tax climate and the capital markets in Russia are improving, making it a friendlier destination for private equity capital than ever before. In addition, a handful of private equity firms that specialize in Russia recently have scored lucrative exits from their portfolio companies. A prominent firm that invests in Russia, Delta Private Equity Partners, for example, recently tripled its money through the sale of Russian bank Deltabank to GE Consumer Finance.

Nice publicity, huh? And here’s a telling sign. The reporter doesn’t mention whether she tried contacting the firm for comment. The assumption, therefore, is that the source is the firm itself. Noteworthy is that the story does mention the guy who formed the fund earlier this year, Colin M. Breeze. He’s a former private equity attorney with law firm Wilson Sonsini Goodrich & Rosati. Wow, well at least he should know what the rules are on this. We did give him a call, but haven’t heard back yet. We’re not suggesting that there’s anything shady going on, for the reason Mendelson gives above. But we’d like to get some feedback, i.e, about whether the laws are clear enough on this — given the apparent differences in interpretations.

Stay tuned…

UPDATE: A helpful reader forwards an article from Venture Capital Journal about the issue. And when a journal that relies on being able to break news about venture capital funding says it “may be” dangerous to make public statements about fund-raising, that’s a statement in itself.

Also, Jonathan Axelrad, a fund formation attorney for Wilson Sonsini, got back to us with this message: The examples we gave him, he says, suggest these people “may very well be doing things they shouldn’t be doing… People should not violate the private placement rules.” However, he added that in any given case it’s not certain whether rules were violated because the start-ups or funds may have already completed their offering and this just didn’t get reported in the article. They may also be doing the fundraising only outside of the US, which is another exemption.

Hmm, we forgot to mention last time, in the case of Axelrad’s former colleague, Colin M. Breeze, that VentureWire even provided Breeze’s phone number. It was a “650” number, right in the heart of Silicon Valley. Still no reply, though.